Consolidated Edison (ED) has a long history of dividend increases, a solid dividend yield, and a reliable cash-generating business.

-Seven Year Annualized Revenue Growth Rate: 4.1%
-Seven Year Annualized EPS Growth Rate: 6.7%
-Seven Year Annualized Dividend Growth Rate: <1%
-Current Dividend Yield: 4.08%
-Balance Sheet: Fairly Strong for a Utility

I calculate that Consolidated Edison is somewhat overvalued currently. Utilities in aggregate aren't particularly value investments at the current time, though there are a few fair ones. MLPs and telecoms are currently more attractive areas for high yields in my opinion, with blue-chip tech, health care, and industrial/engineering firms being attractive areas for dividend growth.

Overview

Consolidated Edison Inc. (NYSE: ED) traces its founding back to 1823. This large utility company serves New York, including New York City, and some parts of northern New Jersey and Pennsylvania with electricity, gas, and steam. It also provides energy infrastructure development services.

The regulated businesses are Consolidated Edison Company of New York (CECONY), and Orange and Rockland utilities (O&R). CECONY serves 3.3 million customers electricity, 1.1 million customers gas, and 1,700 customers with steam, mostly in New York City. O&R serves an additional 300,000 customers with electricity in areas surrounding New York, and over 100,000 customers with gas.

In addition to the regulated businesses, ConEd’s less regulated businesses include Con Edison Solutions, Con Edison Development, and Con Edison Energy. These groups participate in the development of energy infrastructure and the wholesale and trading of energy.

Ratios

Price to Earnings: 16.6
Price to Free Cash Flow: Highly Erratic
Price to Book: 1.5
Return on Equity: 9%

Revenue and Free Cash Flow

(Chart Source: DividendMonk.com)

Revenue growth averaged 6.7% per year over this period, while FCF was erratic and often negative.

Utilities have large capital expenditures that are required to maintain and expand equipment, which can keep FCF on the lower side.

The revenue number is solid, except that the trend has been downward since the middle of the reporting period. This is due primarily to a broad mild reduction in annual energy transmission.

-Total kWh’s of electricity delivered by CECONY were approximately 1% lower in 2011 than they were back in 2007.
-Total sales and transportation of gas by CECONY in terms of mdth were approximately 1% lower in 2011 than they were back in 2007.
-Total steam delivered by CECONY was down over 13% in 2011 from 2007.
-Total kWh’s of electricity delivered by O&R were approximately 2% lower in 2011 than they were back in 2007.
-Total sales and transportation of gas by O&R in terms of mdth were approximately 23% lower in 2011 than they were back in 2007.
-Sales of electric volume (kWh) by Con Edison solutions was up over 28% in 2011 compared to 2007.
-Wholesale of electric energy was way down in 2011 to only about a fourth of what it was in 2007.
-Construction expenditures by Con Edison Development has been mildly down.

These reductions in energy volume, mostly across the board, have had a mildly negative affect on ConEd’s revenue, partially offset by rate increases. Modest revenue increases are currently expected by analysts for 2012 and 2013.

Earnings and Dividends

(Chart Source: DividendMonk.com)

EPS had been mildly erratic, and has averaged 6.7% annualized growth over this period. The chart shows a sharp recovery in EPS from the recession, compared to the previously described revenue figures which were in a sustained downward trend.

Although the consecutive years of dividend increases approaches four decades, the dividend has grown at a tiny pace of less than 1% per year over this 7-year period. Each year here, the company has increased the quarterly dividend by half a cent per share. Fortunately, I believe the numbers show that this pace can modestly quicken over time. Back in 2004, the dividend payout was only one penny less than EPS, resulting in a nearly 100% dividend payout ratio from earnings. As EPS has grown, the dividend has grown more slowly, which has now resulted in a dividend payout ratio from earnings of under 70%. This gap doesn’t have to increase forever, and eventually the dividend can sustainably grow at the same rate as EPS, on average.

Balance Sheet

ConEd’s balance sheet is fairly robust for a utility. Utilities, which are asset-heavy and require substantial investment, need to utilize debt to get a decent return on equity. But this debt is generally reasonably conservative because the cash flows generated by a utility are pretty reliable.

The company’s total debt/equity ratio is a bit over 0.9. For a utility to be under 1 with this ratio is fairly conservative. The interest coverage ratio is over 3, and closer to 4, which is comfortable for a utility. Goodwill is rather negligible. Debt maturities from 2012 to 2016 are reasonably smooth.

Overall, the company is in very good shape here.

Investment Thesis

Consolidated Edison has a rather diversified assortment of products and services in a strong economic area, geographically speaking. The dividend growth has a very long and consistent record, but recently, the dividend growth has not even kept up with inflation. Revenue declines have occurred due to decreases in energy volume, which were partially offset by increases in rates.

Utilities in aggregate aren’t particularly attractively valued at the current time. As they historically have been solid places for dividends, and bond rates have been very low, it’s natural to shift towards dividend paying stocks. But with too many interested investors, comes unappealing valuations.

Risks

As a utility, ConEd has rather reliable operating cash flows and stability, but they do have a number of risks. They are highly regulated, and rely on reasonable regulations to maintain profitability. When their costs rise year to year, they need rate increases to avoid massive decreases in margins. Their operations are at risk to damage from weather, although their areas of operation tend to have fairly mild weather, overall. In addition, economic health affects energy usage. And of course, increases in interest rates affect a company’s ability to roll debt into new debt with similar interest payments, and so for a company that uses substantial leverage, potential interest rate increases can have an impact.

Conclusion and Valuation

I previously analyzed ED back in 2010, and reported that it was a fair investment for a decent income stream but not too great on growth. But since then, the stock has increased somewhat substantially in terms of valuation, and the yield has decreased to only a bit over 4%. The sum of dividend yield and and dividend growth, at only around 5%, isn’t particularly appealing.

Several telecoms and MLPs provide both a higher yield and a higher growth of the income stream . ConEd’s dividend growth may mildly accelerate, but still, I wouldn’t expect much in the way of total returns compared to some of the alternatives out there. Using the dividend discount model, and assuming 2% future dividend growth, the stock is only fairly valued at a discount rate of below 6%, which is rather low. Even various other estimates for dividend growth rates (such as 3% or 4%) don’t provide very robust outcomes for a decent target rate of return, generally resting in the mid single digits. At the current time, I’d look elsewhere for dividend income, unless the stock dips back to the mid-$40′s, where it would more readily provide a mid-high single digit rate of return.

Full Disclosure: As of this writing, I have no position in ED.
You can see my dividend portfolio here.

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Enterprise Products Partners LP is one of the largest MLPs, and benefits from not having to pay Incentive Distribution Rights to any general partner.

-Seven Year Annual Revenue Growth Rate: 27%
-Seven Year Annual Distribution Growth Rate: 6.9%
-Distribution Yield: 4.82%
-Balance Sheet: Fair

EPD is in a position to potentially offer high single-digit returns over the long-term, but at the current time, I’d look for dips to the mid-$40s before purchasing.

Overview

EPD had its IPO in 1998, and has grown considerably since that point. Assets have grown from around $0.7 billion to over $34 billion, which represents nearly 35% average annual growth of their asset base over more than a decade. Master Limited Partnerships are suited towards growth due to their attractive tax structure and reliable cash flows, which together, allow them to constantly issue new units and get returns on this capital that benefits the whole partnership.

The partnership has:
21,000+ miles of natural gas pipelines
17,000+ miles of NGL and petrochemical pipelines
6,000+ miles of crude oil pipelines
190 million barrels worth of liquids storage capacity
14 billion cubic feet of natural gas storage capacity
24 natural gas processing plants
20 NGL and propylene fractionation facilities
6 offshore hub platforms

Revenue

(Chart Source: DividendMonk.com)

This represents 27% annualized revenue growth. EPD, like many MLPs, has accelerated the growth of its revenue and asset base by issuing new units to fund acquisitions and organic growth projects. This way, they can pay out most of their cash flows as distributions, and yet still grow. The number of units outstanding has increased more than fourfold since 2002. Still, unitholder returns over this period have been rather substantial. When MLPs issue new units, as long as the numbers of the deal allow for continued distribution growth per share, it’s usually favorable.

Distributions

(Chart Source: DividendMonk.com)

EPD has increased the distribution for over 30 consecutive quarters. Over the last 7 years, the average annual distribution growth has been 6.9%. The current distribution yield is 4.82%.

Balance Sheet

Like most MLPs, Enterprise Products Partners uses a substantial amount of leverage. The situation is currently stable, with the interest coverage ratio of well over 3. For most dividend stocks, much higher interest coverage ratios are preferable, but for asset-heavy infrastructure businesses, what passes for a good balance sheet is different.

Debt maturities over the next several years are as follows: $500 million in 2012, $1,200 million in 2013, $1,150 million in 2014, $650 million in 2015, $750 million in 2016, and $8,500 million in cumulative years after that. In comparison, EPD brought in $3,300 million in cash flows in 2011. The partnership, therefore, appears financially solid.

A risk, though, would be an increase in interest rates. If the business has to roll its debt over into higher interest debt over time, it could squeeze profitability a bit. Interest rates only have one direction to go, and that’s up. But with a comfortable-enough coverage ratio, and a fairly long successful operating history for an MLP, EPD seems well-prepared for any realistic changes.

Investment Thesis

The MLP has raised quarterly distributions for over 30 consecutive quarters. The partnership is well-diversified in terms of commodity types and geography. Their assets center around Texas and Louisiana, but stretch across the U.S. from the Gulf of Mexico to the Marcellus Shale to the Eagle Ford Shale to the Permian Basin, and so forth. Practically all major domestic gas energy deposits are serviced by EPD.

No IDRs to Pay
A key advantage to EPD is that they no longer have to pay any Incentive Distribution Rights, thanks to a merger with their general partner, Enterprise GP Holdings, in 2010. Most MLPs have to pay IDRs, which means they pay out a growing percentage of their cash flows to the general partner as they grow their distributions to the limited partners.

This is fine at first, because it gives management a huge incentive to raise distributions and grow the whole partnership. But after a while, when the percentage of payments increases to the upper thresholds of the agreement, it can be an anchor on distribution growth for the limited partner. When these upper thresholds are reached, the general partner often still does fine, because at that point, they benefit both when limited partnership distributions are increased and when the number of limited partner units (and more particularly, the asset-base and overall cash flows) grows. Limited partners, however, don’t directly benefit from the increased number of units unless it allows the partnership to grow their distributions.

So for example, Energy Transfer Equity (ETE), the GP of Energy Transfer Partners (ETP), was able to grow its own distribution to unitholders even though ETP has not been able to do the same for its own unitholders. ETE even had to temporarily waive IDR agreements for ETP on a piece of their new acquisition for the deal to benefit everyone involved.

Enterprise Products Partners, by merging with its GP, has now avoided this problem.

Recent Developments
EPD is not at a loss of growth opportunities or places to invest capital.

-Enterprise Products Partners and Enbridge are set to expand the Seaway Pipeline to 850,000 barrels per day by 2014. This is will add a 500 mile, 30-inch pipeline.

-Enterprise Products Partners agreed to a joint program with Anadarko Petroleum and DCP Midstream. This will be a 435 mile pipeline from Colorado to Texas, expected to begin service in late 2013.

Risks

The three key risks for EPD are:
-Interest Rate Risk
-Catastrophe Risk (including Hurricane Risk along the Gulf)
-Commodity Price Risk

In addition, as an MLP, investors have additional tax filing complexity. Adding onto this, with budget deficits and tax reforms, it’s always possible that the tax advantages of the MLP structure could change.

Conclusion and Valuation

Overall, I view EPD as a solid business, but the key question always is whether the valuation is reasonable or not. For an MLP, a distribution yield of under 5% is fairly low. Over the last seven years, the distribution has grown by slightly under 7% per year.

If the dividend discount model is used, and 6% distribution growth is assumed for the next 5 years followed by 5% distribution growth thereafter, and a 10% discount rate is utilized, then the fair value is calculated to be around $48/unit. At the current price of $52, while I don’t think it’s a bad investment by any stretch, I’d hold off and look elsewhere, or for price dips. Acceptable discount rates and estimates on long-term distribution growth vary enough to provide a range of acceptable values. If one is willing to accept returns in the high single digits with little margin of safety other than the strength of the business, however, the current price is fairly easily justified.

Personally, I’d be more interested in the units in the mid-$40′s.

Previous Analysis: Canadian National Railway (CNI)

Full Disclosure: As of this writing, I have no position in EPD. I am long ETE.
You can see my dividend portfolio here.

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